2020 with its historic pandemic presented airframe OEMs with hurdles that demanded problem-solving and a willingness to pivot from the traditional way of doing things. To manage cost many had outsourced components and reduced inventories. The pandemic provided production breathing room and an opportunity to improve global supply chain management.
Faced with demand challenges Airbus developed solutions. Reacting to the 66% decline in passenger kilometers (the low point of 2020), Airbus reduced civil aircraft production, embarked on workforce cuts, and increased its focus on making its manufacturing processes more cost efficient. Airframe sections and components of aircraft are made all over Europe before bringing them in for final assembly in Hamburg and Toulouse. It is a tried and tested supply chain, using specific expertise present in each region. Airbus expects to deliver 566 commercial aircraft in 2021, matching 2020 deliveries (863 were delivered in 2019). For 2020 the consolidated company lost €1.133 billion (compared to a €1.362 billion loss in 2019). Deliveries surged in the fourth quarter and generated a €1.6 billion profit. But with continuing global demand uncertainty, Airbus has shelved plans to open a dedicated final assembly line in Toulouse for the A321 narrow body.
Airbus has 3,000 A321neo orders. Boeing 460 737 Max 10 orders, the nearest competitor to the A321neo (the MAX carries fewer passengers and has less range). Airbus’ A321XLR design, which added a third fuel tank, will allow the XLR to fly up to 10 hours without refueling. With CFM Leap-1A engines the A321XLR will operate with a 30% reduction in fuel burn per seat. Analysts argue Boeing must (re)launch design of a new mid-market jet to effectively compete with Airbus’ A321 neo (and the A321XLR), but Boeing reported its largest ever annual net loss in 2020 ($11.9 billion) which includes a series of fourth quarter charges totaling $8.3 billion1.
Boeing’s strengths were built up over decades. Now Boeing’s near-term recovery rests on a return of the MAX and a ‘business transformation’ that includes refocusing on technical and engineering expertise, changes to its manufacturing footprint, and a commitment to safety in cooperation with worldwide regulatory authorities. Boeing uses over 50 suppliers from multiple countries across the world (India, South Korea, Italy, Japan, Australia, China, Sweden, France, and Canada). Driving down the cost of production was a major factor in Boeing’s supply chain decisions. Improperly managed outsourcing and a focus on reducing cost led to the 737 MAX flight control design issues, delayed delivery of the 777X, and quality issues with the 787’s carbon fiber composite fuselage joints.
Countries are slowly starting to reopen their borders to travelers after months of lockdowns. The UK government announced February 22 international travel ‘should’ resume (but no earlier than May 17). Domestic U.S. traffic will be driven by the decisions of the soon-to-be-vaccinated traveling public.
For equipment investors, adapting to market conditions requires a focus on equipment types, credits, and tax risk. Leverage your network. Discuss portfolio solutions. Call RESIDCO.
Glenn P. Davis, 312-635-3161
1 $6.5 Billion on the 777X, $465 Million for 737 MAX production issues, $275 Million in ‘production inefficiencies’ on the KC-46A tanker, $290 Million for Boeing Global Services and a $744 Million MAX settlement with the U.S. Government.
Dr. Anthony Fauci has predicted, “it will be open season for vaccinations in the U.S. by April”. Supply boosts are expected to allow most people to get shots to protect against COVID-19 by then. Herd immunity could be achieved by late summer. With continuing low-interest rates and Fiscal stimulus provided by the CARES act (passed March 2020, authorizing $2.2 trillion), the 2020 COVID Economic Relief bill (signed December 2020, which authorized an additional $900 billion in spending), a possible third stimulus of $1.9 trillion, and a yet to be defined bipartisan ‘infrastructure’ spending package the economy is set for a comeback. As the vaccines roll out significant pent-up demand, caused by the pandemic lockdowns, will lead to a recovery in the second half of 2021.
Rail traffic is often used as a measure of broad economic activity. This January ten out of twenty carload categories had higher volumes than in January 2020. Intermodal volume and carloads of chemicals (on a weekly average basis) were higher than ever before. Chemical carloads were up 4.4% year over year in January, their biggest percentage gain in 10 months. Intermodal containers and trailers set new all-time records, up 12.1% over January 2020 (the fourth straight double-digit monthly percentage gain). Volumes are up at West Coast ports (Long Beach, Los Angeles, Oakland, and Seattle/Tacoma) and East Coast ports (Savannah, Virginia, and Charleston). Carloads of grain were higher than any month since October 2007 (the January year over year carload gain was 40%, the largest year over year monthly percentage gain for grain for U.S. railroads on record). And carloads of primary metal products, lumber, paper, and iron and steel scrap were higher than they’ve been since the pandemic began. The traffic category which most closely correlates with GDP is “industrial products” which is an aggregate of seven different carload categories representing a cross-section of U.S. industry1. Iron and steel scrap were up 5%, the most for any month since January 2015. U.S. plus Canadian carloads of lumber were up 8.9%, the most for any month since May 2019, and the fifth straight year-over-year monthly increase.
Over 90% of U.S. coal consumption is for electricity generation, and coal’s share of electricity generation (at 19%) remains behind natural gas (41%) and nuclear (20%). Equipment oversupply continues in both the Rail (24% of the fleet in storage, 396,867 railcars) and Aviation markets (a significant fleet surplus is expected through late 2022). International passenger aviation will wait for travel restrictions to be lifted. Airfreight demand is so strong experts predict the market will be back to pre-pandemic levels by the end of March.
With the highest probability scenarios priced in, knowledgeable investors anticipate unforeseen circumstances. As the economy recovers, fleet plans will change and aircraft that have been written down will again generate cash. Opportunities lie in those out of favor assets that offer strategic returns. A focused asset manager can identify secondary market transactions that combine current revenue generation with remarketing/resale opportunities.
Invest productively. Call RESIDCO.
Glenn P. Davis, 312-635-3161
1 “Industrial Products” include chemicals, paper, metal products, autos & parts, crushed stone, sand & gravel, metallic ores and stone and glass products.
Energy is a universal and necessary requirement for both rail and commercial aviation. Diesel-powered locomotives pull freight on all nonelectrified railways around the world. Gas-powered turbines made intercontinental passenger flight efficient and affordable. Because many believe fossil-fuel energy unfavorably impacts the environment, there is a growing belief that climate risk must be considered in evaluating transportation portfolio investment opportunities.
On his first day in office, Biden signed an executive order revoking the Keystone XL pipeline permit, signaling climate as a priority. His order effectively shut down a 12-year cross border project that would have carried 830,000 barrels a day of Canadian heavy oil-sand crude to U.S. refiners on the Gulf Coast (U.S. refiners purchase 98% of Canada’s oil exports). According to the Canadian Government, Canada’s proven oil reserves are third in the world behind Venezuela and Saudi Arabia. Canadian producers have limited and costly options for getting their oil to buyers. It trades at a significant discount to the West Texas Intermediate benchmark to cover rail transportation costs. The cheaper Canadian crude makes it one of the most profitable for U.S. refiners. Without the Keystone pipeline, the Burlington Northern Railroad will continue to carry crude as it moves rail tank cars to the Gulf Coast. Railcars are recognized as a more ‘sustainable’ form of investment, whether in terms of CO2 emissions or energy consumption per load when compared to other forms of transport1.
Aviation’s share of global carbon emissions is significantly below that of cars and trucks. But at high altitudes exhaust contrails form heat-trapping cirrus clouds. Can carbon-neutral flight be achieved? Boeing committed on January 22nd to ensure all its new commercial aircraft are capable and certified to use 100% ‘sustainable2 aviation fuel’ by 2030 (existing regulations allow aircraft to use a blend of 50% sustainable and 50% conventional jet fuel). Airbus has announced plans to design aircraft that rely on a turbofan design that includes a modified gas-turbine engine running on hydrogen rather than jet fuel (the hydrogen would be stored in tanks located behind the plane’s rear pressure bulkhead). Rolls-Royce committed to using its technological capabilities to play a leading role in enabling aviation, rail, and power generation to reach net-zero carbon by 2050. GE is researching advanced electric propulsion and fuels to achieve carbon-neutral flight. Last December United Airlines pledged to go ‘100 percent carbon neutral’ by 2050 by using carbon removal ‘direct air-carbon-capture technology’ that would remove an equivalent amount of carbon produced by its aircraft and thus allow its planes to fly on fossil fuels forever. Boeing’s 787 and Airbus’s A350 already emit significantly less carbon than the older jets they are replacing by using lighter materials and more efficient engines.
Climate isn’t the only thing changing. General Motors announced on January 28th it will end the sale of ‘all’ gasoline and diesel-powered passenger cars and light sports utility vehicles and will only produce electric-powered cars and SUVs starting in 2035. Transitioning to carbon-free transportation will be difficult to accomplish, even if vigorously pursued. The risks include shifts in policy, technology, and existing equipment valuations. For insight into opportunities that will be created during this challenge call RESIDCO.
Glenn Davis, 312-635-3161 davis@residco.com
1 “Railcars are a sustainable mode of transportation and play an important role in the industrial supply chain by transporting our country’s most important products across the North American continent in an environmentally-friendly manner.” Trinity Industries.
2 Sustainable aviation fuel reduces CO2 emissions up to 80%.
A consensus is typically believed to be a rough picture of what is to come. By nature, we tend to move in crowds and weigh recent experience more heavily. Not knowing any better, we extrapolate the future from the present. Most are now expected to be vaccinated by mid-2021. When the pandemic clears, economists think GDP could grow 4 to 5% or more. The Fed will keep interest rates low, unemployment will be down to 5%, and inflation up to 2% by the end of 2021. Central bankers will continue to target growth, inflation, and unemployment1 (total nonfarm employment rose by 245,000 in November and the unemployment rate edged down to 6.7%). Growth, income, and the ability to service debt depend on a return of robust demand. The unexpected? The next Administration’s announced policy preferences are contrary to growth.2
Domestic aviation markets will recover with low-cost carriers leading the way. The low-cost carriers can flexibly modify schedules, follow changing traffic demand patterns, and move aircraft around to take advantage of those changes. Southwest Airlines (known for its discount fares) is starting flights at O’Hare International Airport in 2021. It will keep its existing hub at Midway International Airport and is expected to continue using its fleet of existing 737s. With Southwest at O’Hare, American and United will have to adjust. Similarly, Ryanair Holdings, Europe’s largest low-cost carrier, is in talks with airports in Germany, Austria, Spain, and Portugal. Ryanair is banking on the MAX to add capacity when air travel rebounds. With the MAX back the Cirium Fleet forecast anticipates 360 MAX deliveries in 2021 with 570 MAX in service by the end of the year.
To smooth relations with the incoming Biden Administration, and as part of a strategy to de-escalate trade tensions in order to allow the U.S. and UK to move forward to the next phase of their trading relationship, the UK has said it will suspend retaliatory European Union tariffs on Boeing jets resulting from the EU-U.S. dispute over subsidies to their respective commercial airframe makers after the Brexit transition period ends on December 31st. But the fleet surplus will continue through late 2022 as local issues continue to impact international travel (since recent news of a new variant of the COVID virus came out of the U.K. nearly 50 countries have again banned flights to and from the U.K.).
Domestically, certain segments of U.S. manufacturing have made surprisingly strong recoveries. Auto production is back to pre-pandemic levels and residential construction activity has been robust. Rail intermodal has recovered strongly as online e-commerce replaced traditional retail store sales.
This has not been a normal recession. The pandemic interrupted the supply of goods and eliminated global passenger transport. The recovery will be uneven, and available facts suggest 2021 will be challenging. With a cost base better than network carriers, low-cost carriers are seizing the opportunity for market penetration. Transportation equipment leasing and flexible asset management solutions work to keep the economy moving. As the recovery unfolds your portfolio should hold the right mix of air and rail transportation assets. For opportunities that maintain portfolio cash flow in this new environment call RESIDCO.
Glenn P. Davis, 312-635-3161 davis@residco.com
1 Caution: current monetary policy inflates asset pricing.
2 The Biden team believes the role of government is to direct and manage the private economy through macroeconomic policies; increasing taxes, government regulations, and spending (trillions) more than collected. Even at current low-interest rates, the U.S. currently spends as much on interest as the combined budgets of Commerce, Education, Energy, DHS, HUD, Interior, Justice & State.
Clean energy, zero-emissions, and an incoming Administration poised to rejoin the Paris Climate Agreement. This year’s Covid lockdowns have cut global fuel demand 30% driving a global drop in carbon emissions (down 7% in 2020). The lockdowns impacted transportation which accounts for 24% of global carbon dioxide (CO2) emissions. Road travel (passenger vehicles and trucking) accounts for 74.5% of transport emissions. Aviation (which often gets the most attention in climate change discussions) accounts for only 11.6% of transport emissions. Rail freight emits very little – only 1% of transport emissions. By December year over year road transport emissions were down 10%, aviation emissions down 40%. Globally, U.S. and European Union emissions were down 12% and 11% respectively (China a 1.7% drop). In the U.S. refiners are idling plants in response to a drop in gasoline demand. In California, the country’s most populous state, the Governor signed an order banning gasoline-powered car sales by 2035. Many expect electric vehicles will offer a viable option to reduce emissions if conventional gasoline-powered vehicles are phased-out.
The United States is the world’s largest petroleum consumer. Through November U.S. rail carloads of petroleum and petroleum products were down 13.8% from 2019. Gasoline prices are turning higher on hopes the Covid vaccines will return the world to normal levels of oil-fueled travel in 2021 (West Texas Intermediate crude, recently trading near $45 per barrel, could increase to $50 per barrel). U.S. coal is consumed at electric power plants. Approximately 70% of that coal is delivered by rail; it remains by far the highest volume carload commodity for U.S. railroads. But coal volumes are down 25.5% year over year through November mainly because of the increase in U.S. natural gas production (due to extended fracking through horizontal drilling) which has led to sharply lower natural gas prices, making electricity generated from natural gas much more competitive.
Commercial air passenger flights are estimated to account for 73% of total U.S. jet fuel consumption. Lower fuel prices (U.S. Jet A1 Fuel Spot Price, December 11, $1.37) allow existing aircraft to remain in service longer as Carriers evaluate flights, using smaller aircraft where possible, and dropping routes that will not be profitable based on expected cargo and passenger revenue. As newer aircraft are delivered, their upgraded engines will offer more fuel-efficient propulsion, less noise, and less pollution. CFM’s LEAP-1B (737MAX) and LEAP-1A(A320neo) offer fuel efficiency of 15% above previous engines. Pratt & Whitney’s Geared Turbofan (A320neo, A220) delivers similar lower fuel burn per seat. Yet low jet fuel prices diminish the benefit of these costly new engine technologies. And OEM margins on new engines must be sacrificed to secure the longer-term and higher-margin aftermarket business.
The OECD’s economic outlook expects the global economy will contract 4.2% in 2020 and then recover that loss in 2021. In the U.S., the forecast is for 4% GDP growth in Q4 2020 and 3.3% in Q1 2021. Even with the headwinds caused by a fall virus resurgence, the economy is recovering. With the distribution of vaccines, the level of economic activity will increase. The business case for transportation investment covers a 20-to-30-year horizon. Investment thinking requires identifying key trends and responding. Call RESIDO.
Glenn P. Davis, 312-635-3161
On November 18, 2020, the FAA rescinded its Emergency Order that had grounded the 737 MAX since March 13, 2019. The order allows Boeing to resume delivering the jets and will allow U.S. passenger flights to resume pending mandated fixes and additional pilot training. American Airlines had taken delivery of twenty-four MAX aircraft before the grounding and expects to take ten more before the end of this year. Starting December 29th, with one flight per day scheduled between Miami and New York’s LaGuardia, American will be the first air carrier to put the MAX back into regular commercial service. United, with 14 MAX aircraft currently in their fleet, will return the aircraft to service in the first quarter of 2021.1 Southwest, the largest 737 operator, will return the MAX to service in the second quarter of 2021. Other county regulators will individually determine airworthiness requirements and timing for a return to service.2 Even with MAX deliveries resuming Boeing executives do not expect the company to generate cash in 2021.
The collapse in traffic caused by the Covid pandemic forced a shift from 2019’s inability to meet demand to a 2020 industry-wide fleet oversupply. Air carriers parked 30% of their fleets (27% single-aisle, 41% twin-aisle).3 Both Airbus and Boeing have reduced production and cut jobs. Through October Boeing delivered just 111 jets compared to Airbus’ 413 jets. Operators are generating cash by selling aircraft to leasing companies and leasing them back. Delta entered into sale-leaseback arrangements to raise $1.2 billion. United has even sold 737 MAX models that have not yet been delivered.4 To meet changing demand patterns Southwest (with their all Boeing 737 fleet) is considering replacing their 737-700s, which are nearing retirement, with newer Airbus 220s to serve shorter to medium-haul markets more efficiently (Delta has ordered 95 A220 aircraft, 45 A220-100s and 50 larger A220-300s).
Domestic flight operations break-even points are estimated to require 60% to 70% of pre-pandemic operating revenues. The timeline for U.S. passenger operations to reach these levels remains uncertain. It is clear single-aisle aircraft that serve domestic markets will recover first. Thanksgiving Holiday traffic confirmed this. Air Carriers struggled with flight cancellations caused by pilot shortages as airport screenings rose above 1 Million, their highest in more than eight months. Wide-body routes continue to be negatively impacted by international travel restrictions. Uniform measures must be developed to support a return of international passenger flight. European air traffic control (“Eurocontrol”) outlined its ‘most optimistic’ scenario with traffic returning to pre-pandemic levels by 2024 but said the ‘most likely’ scenario would be 75% by 2024.
With vaccines expected to be available in the U.S. late December (widespread public availability by mid-2021), equipment opportunities will exist in the fleet surplus that is expected to continue through 2023. It is private capital allocation that identifies the opportunities that raise productivity. As the recovery begins, remain focused on what you can control. Strengthen customer relationships and position your equipment portfolio to deal with 2021’s flight operations challenges. Contact: Glenn P. Davis CEO 312-635-3161 davis@residco.com
1 Southwest has 233 MAX aircraft on order. Thirty-four have been delivered and are currently in storage.
2 European regulators are expected to lift the 737 MAX grounding in January 2021.
3 Cirium Fleets Analyzer, October 26, 2020.
4 United has sold and leased back 22 planes in bid to conserve cash, CNBC, April 19, 2020.
Air and Rail networks have lost substantial revenues. First Rail freight traffic due to trade disagreements, tariffs, and the downturn in coal, and then both Air and Rail due to the impact of the Covid-19 shutdowns. Economics remains challenging. The landscape that has emerged was unexpected. Air Carriers are zero base budgeting equipment needs, personnel (payroll support ends in September), and optimizing networks. Flying point-to-point with few passengers onboard is not economically viable. Legacy carriers are rediscovering the virtues of ‘hub-and-spoke’ systems which work to maximize load factors. Operators are retiring older equipment from their fleets, preferring newer more fuel-efficient equipment and technology.
An example is the jumbo jets which are too big for current passenger demand. The International Air Transport Association updated its projection of when it expects passenger air travel to return to pre-Covid-19 levels – 2024. This year, when Boeing finishes the last fifteen 747 freighters on order, 747 production will be discontinued. The last passenger 747 was delivered in 2017. Older 747-400s are not expected to fly again. There are only 35 of the newer 747-8 variant flying. These four-engine aircraft are not as fuel-efficient as newer design dual-engine aircraft. The pandemic has grounded almost all of Airbus’ superjumbo A380s and Airbus will close A380 production delivering the last unit in 2021. The A380 was designed with little cargo space compared to the twin-engined A350 which has twice as much cargo capacity as the four-engine A380. With 500 seats on average, the A380 is just too much aircraft and too expensive to operate when most seats are empty. Engine issues have delayed Boeing’s 777X which when certified will compete directly with the A350.
As fleets are repositioned trends are becoming apparent. The pandemic has accelerated the adoption of video conferencing. Many see this resulting in a long-term reduction in higher-margin business travel. We’ll have to wait to see if Robert Crandall, former chief of American Airlines, will be right when he said, “You are never going to see the volume of business travel that you’ve seen in the past.” Lower margin leisure travel is expected to return once a vaccine is available. But even after a vaccine has been developed and tested it will take time for acceptance and coverage. Then countries will have to standardize entry and documentation requirements for international travel to return. Class One Railroads, using Hunter Harrison’s Precision Scheduled Railroading (“PSR”) strategy, are removing railcar capacity, locomotives, and employees. Their focus is on reducing ‘operating ratios’ and improving short-term profitability.
The unexpected demand environment is forcing Bank Lenders, Operating Lessors, Private Capital, and those who service and support aviation and rail equipment investment to reconsider their investment strategies. Success rarely comes from projecting trends. Rather it comes come from insights that define future demand. Even with no additional Washington stimulus, another 1.4 million jobs were created in August, unemployment declined to 8.4%, and labor force participation increased to 61.7% (only 1.7% below its February level).
The best investment strategy in a low demand environment? Maintain liquidity, competitive market position, and key talent. Be responsive to opportunities that deliver long-term value. Call RESIDCO.
Global freight traffic flows are recovering. U.S. and German manufacturers surveyed in late August reported a ‘jump’ in export orders, “Container traffic is approaching the level reached before the corona crisis”. In the U.S. seasonally adjusted imports (inbound TEU’s) are up significantly on the West Coast, and Domestic North American Intermodal container volumes have fully recovered to pre-pandemic volumes*. The purchasing manager’s index rose to 54.2 in July from 52.6 in the previous month (which was above expectations of 53.6, and its highest reading since March 2019). Economically sensitive Rail carload freight (excluding Ag/Petro/Coal) has improved but is expected to be down for the balance of 2020.
First it was tariffs and trade tensions that impacted freight traffic. Then the coronavirus lockdowns disrupted domestic and international supply chains. During the second quarter of 2020, the World’s largest economies experienced the deepest contraction in six decades (record keeping began in 1960). The previous largest drop in a single quarter had been -2.9% in the first quarter of 2009. The pandemic exposed the strategic vulnerabilities of reliance on China as a sole source, low cost supplier. Unnoticed until now China managed to capitalize on our appetite for access to their markets. It has been a one-way street as China is now ‘adjusting’ their export of pharmaceuticals, laser technology, cryptography, and artificial intelligence, given the ‘rapid development’ of China’s ‘industrial competitiveness’. National security concerns will impact future trade volumes as the world’s two largest economies drift apart.
Hope for a rapid vaccine deployment is keeping the Dow Jones Transportation Average near a record. But weakening passenger demand in the US domestic aviation market and continued restrictions on international travel weigh heavily on airline recovery efforts. The proportion of the global passenger jet fleet in storage has remained at approximately 33% with fewer than 30% of narrow bodies inactive versus more than 40% of widebodies. This reflects the proportionally higher passenger demand for domestic and intra-regional travel compared with international long haul. The most popular aircraft in the U.S. fleet remains the Boeing 737-800 and Airbus’ A320/321 (the MAX is now expected to return to service in early 2021).
The Conference Board’s July economic indicators, both leading and coincident, are pointing to a recovery. Economists expect a strong rebound in the Third Quarter. But as long as the pandemic lingers, the economic shock across the aviation and rail equipment leasing sectors will continue. As the recovery unfolds the big picture question will be how will existing aviation and rail equipment capacity (and supply chains) be efficiently managed while we wait for demand to fully recover? Despite low interest rates and fiscal stimulus, low utilization of existing fleet assets is likely to continue through 2021. Demand remains uneven. A third of the railcar fleet is in storage, railcar lessors are reporting pricing pressure on lease rates, aircraft manufacturers face order deferrals, and aviation lessors are faced with widespread restructuring challenges. We are better than before,but not yet back to pre-pandemic levels. The present requires the ability to identify investment opportunities that perform in this uncertain environment. It’s time to prepare for the rebound. Call RESIDCO.
* Making Sense of What the Economy and Freight Markets are Telling Us, August 27, 2020, FTR + Midwest Association of Rail Shippers.
As the U.S. economy began to reopen, investors looked past the pandemic and optimism drove financial markets to within 4.5% of their all-time high. Lockdowns eased and a stronger than expected jobs report (2.5 million new jobs added in May) indicated the U.S. economy was impatient to reopen. American and Delta reported progress in summer demand, shoppers are returning to stores, and Europe and Asia have restarted portions of their economies. After the Fed announced plans to keep interest rates near zero for an extended period (at least through 2022 indicating they are expecting an extended recovery) the markets retreated.
The virus remains a reality and there are concerns over a possible recurrence of COVID restrictions. But a vaccine is expected to be available within a year (perhaps as early as this fall) and a June Wall Street Journal survey reports 69% of economists expect a recovery in the third quarter. The uncertainty that is driving daily volatility is dictating a ‘bumpy’ recovery.
The nature of the passenger aviation industry is such that flight operations will have to deal with a slower recovery than the wider economy. S&P Global Ratings expects global air passenger numbers to drop 50% to 55% in 2020 compared with 2019, and travel demand to remain below 2019 levels until 2023. Idle U.S. passenger aircraft peaked in mid-May. United is reinstating flights at over 150 of its U.S. and Canadian destinations in July to 30% capacity. American announced it will increase domestic flights in July, to 55% of its July 2019 schedule. Recovery of global passenger travel will take additional time and require the implementation of agreed international safety procedures and removal of quarantine restrictions.
The lack of passenger revenues is driving temporary conversions of passenger aircraft to freighters and increasing sale-leaseback financing activity (since March 1st lessors have closed multiple transactions with Delta, Southwest, American, and United). Virgin Atlantic increased its cargo-only flights by more than one-third to nearly 600 in June, breaking its record for freight carried in May. British Airways began operating two 777-200s as cargo-only flights with cargo on seats. China Eastern Airlines is using 13 reconfigured A330-200s in temporary cargo service. Emirates has converted 85 of its Boeing 777-300ERs as stand-in freighters (in addition to their 11 777Fs). Some carriers are considering repurposing 737NGs as freighters and then arranging to replace them with MAX sale-leaseback financing. Older A380s can be moved to second lives as freighters. A ‘shared space’ 747-400M, in service with KLM since 1989 continues to fly. It has capacity for 268 passengers with a locked bulkhead on the main deck separating the cargo area from the forward passenger cabin.
Rail volumes remain stressed. U.S. rail freight carloads fell 27.7% in May from the same period in 2019. That is the largest year over year decline for any month on record. May was also the worst month for U.S. coal carloads in history. Cars in storage increased to 520,729 units. But consumer confidence rose, and both the Purchasing Managers and Non-Manufacturing Indexes rose. ‘All indications are that we’re starting to bottom out”.
To update your evaluation of the duration and volatility of factors influencing aviation and rail asset values, call RESIDCO. It’s key to setting the stage for tomorrow’s portfolio growth.
Domestic economies are beginning to reopen as evidenced by the number of TSA airport security screening checks. They totaled 87,534 April 14th and by May 25th had tripled to 257,451. “We’re past the trough in terms of peak damage”. Much of the pickup reflects the states’ decisions to open parts of their economies. While global supply chains remain fragile the mechanics of transportation decision making remain unchanged. What is the payoff from the trip? Is it high value/time-sensitive? Where is traffic currently being allowed, and what mode is most cost-efficient?
Globalization fostered the ever-increasing specialization of labor across countries. The Covid-19 crisis has demonstrated the weakness of over-reliance on extended supply chains, whether for manufacturing automobiles, aircraft, or pharmaceuticals. ‘Just in time’ easily can become ‘just too late’. An example: the U.S. relies heavily on Mexico for parts and vehicle production. Thirty-nine percent of auto parts ($60.8 billion) were imported from Mexico in 2019. Without Mexico, the Detroit auto industry will be unable to effectively restart production. Going forward the private sector must re-examine supply links, border restrictions, risks, and define solutions.
Increased taxes financed the spending that helped the U.S. get out of the Great Depression in the 1930s. From 1929 to 1939 the corporate tax rate rose from 11% to 19%, capital gains tax rates went up from 12.5% to 22.5%, and personal income tax rates jumped from 24% to 62% (the top marginal rate was 91% in 1960). With the current level of deficit spending and lost tax revenues due to lockdowns, it’s not hard to imagine higher taxes. But borrowing now amounts to a transfer of economic activity from the future to the present.
With air travel demand picking up, how full will planes be? Single-aisle airframes generally have 3+3 seating. Leaving all middle seats vacant implies a maximum load factor of 67%. On a fleet-wide basis, the International Air Transport Association has said “social distancing would mean a maximum load factor of 62%.” That would require a different business model than the airlines have been using. Break-even loads vary with changing cost and airfare fluctuations (in 2019, the systemwide beak even load factor was 73.8% while the actual load factor was 84.6%).
Class One Railroad operations remain strong with freight car velocity, terminal dwell, and car trip compliance improving. The Roads are running fewer and longer trains on tight schedules (Precision Scheduled Railroading). As traffic has declined, crews, locomotives, and freight car resources are being ‘balanced’ to meet the lower current volumes and improve operating ratios. New equipment deliveries are down and an equipment surplus hangs over the industry.
The Global economy: the European Union’s borders remain closed to non-nationals until mid-June, and China has suspended entry of foreign nationals. U.S. tensions with China are escalating over trade, technology theft, the coronavirus, and Hong Kong’s independence. Managing a transportation portfolio in this turbulent ‘New Normal’ requires an ability to identify and seize opportunities the markets are currently offering. As demand recovers, focus on improving your odds of success. Call RESIDCO.
RESIDCO’s size and wholesale capability is a competitive advantage. We respond quickly and creatively to ever-changing market conditions.
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